I've been thinking about this quite a bit. In fact, I've probably overanalyzed it at this point, so I'm going to throw it out to the class for comment.
We Rule Maker Portfolio managers have been massaging the method by which we allocate the monthly $500 to one of our companies. The system that we've come up with is pretty good, I think. Over the first week of the month, each writer puts forth an argument for a certain company, then the last person to write that week selects the company based upon these arguments. I trust my fellow Rule Maker writers to make good decisions, so I've been pretty happy with the outcome.
But my question is, are we being true to the basis of the Rule Maker Portfolio? And more importantly, is this Foolish? We are spending nearly a quarter of our writing bandwidth discussing what company we need to buy based on where the universe of Rule Makers is at that given moment. So, some of us like the stocks that are being knocked down for some reason, some like the ones that are shooting the lights out. And in any case, we trot out these significant arguments as to why the company we select deserves the $500 worth of love.
But aren't these companies already Rule Makers? In our buy report for each company, we spelled out, in excruciating detail, the rationale for why it is the dominant brand, that it has all the qualitative and quantitative criteria.
I'm of a couple of minds here. One is that companies, no matter what the appellation we give them, are not created equal. Cisco (Nasdaq: CSCO) may in fact be a superior company to T. Rowe Price (Nasdaq: TROW). So even though we have chosen to invest in both, it would be "portfolio management theory" of the worst kind to elect to put money into T. Rowe just to keep our holdings in balance. But at the same time, if we are convinced as a group that T. Rowe was poorly selected at the outset, then it is contrary to the Rule Maker theory that we hold it.
And that's the thing. The Rule Maker is supposed to measure the performance of a select group of companies over the course of a decade, a truly long-term buy and hold (LTB&H) perspective. But at the same time, we are by design looking at shortened time frames each and every time we make a monthly installment. How we balance these two mindsets is crucial to the viability of the Rule Maker Portfolio as a valid proxy for the original thesis -- that we can select a small portfolio of top-dog companies, hold them forever, and gain superior results.
At various times, there have been some really deep reviews of this inherent conflict on the Rule Maker message boards here at the Fool. LTB&H investing means that we should concentrate less on the current price movements of a share and focus instead on its potential for long-term growth. But each person's definition of long term is a little different. And how do we ensure that we are in fact focusing on the right thing when we look at each monthly investment?
I think that the monthly addition is great, because it truly mimics how most people, most Fools invest. We don't each start with a certain amount of money, invest it all, and then never add anything to it. Rather, most people periodically add to their portfolios. And when they do, they must choose a company or two in which to put it. There are ways to invest that limit "friction" (the amount of money paid to brokerages to do the transaction), most notably dividend reinvestment plans. But in the majority of situations, it is not prudent to divide an investment among several companies, as the transaction costs become too high a percentage of the investment capital. As a rule of thumb, I do not allow my transaction costs to be more than 1% of the total amount invested. I use Waterhouse, with $12 trades, so the minimum I can then invest at one time is $1,200. But that's just me and my rule.
The point is that each of us must use some method to vet out the company we want to invest in at any given point, and we are essentially deciding at that moment what is the best place in the world for our money. That's a pretty heavy way to think about it, eh?
But since there is a committee in charge (so to speak), we each have a slightly different idea about how to get to that point. Tom Gardner advocates looking at the Rule Maker Ranker and going with the highest-scoring company, whereas Matt and Phil use their quant chops to get down and dirty with the financial models of each company. Zeke and I tend to look for places where the market has priced a great company inaccurately. And Rob? His rule is ABM: Anything but Microsoft (Nasdaq: MSFT). (That's a joke, Rob.)
DavidGoldman and markandsusanv, some of the most highly respected Fool contributors on the Rule Maker message boards, have discussed a more mechanical approach, one I'd like to examine closer. The concept is simple: Using backtested data, the best returns for the Rule Maker would come from keeping the companies in the portfolio balanced. This would not require that we sell the "hot" stocks in the portfolio, but rather, all things being equal, that we should add to the companies that make up the smaller portion of our portfolio. By doing so, we allow the winners to run but take advantage of potential "sales" for other companies.
The corollary to this is that it will only work if we are convinced that any and all companies have retained their status as a Rule Maker. Because, face it, a collapsing company is not a good investment, no matter what the price. By retaining a mechanical screen backed up with a commonsense approach, the Rule Maker Portfolio MAY be a more accurate, lower-risk scenario. Additionally, we could have a much more defined sell strategy. Namely, if we are convinced beyond a shadow of a doubt that a company is fundamentally down-and-out to a point that it becomes senseless to include it in any rebalance screen, then it is ipso facto not worth it to hold the company at all.
I'll be looking into this more over the next few weeks. For now, as always, your comments and observations are appreciated, and in fact will help us refine the Rule Maker approach to be as rock-solid in execution as it is in conception.
Fool on! Narr weiter!
Elsewhere in Fooldom today, Phil offers up a Q&A on Cisco as part of his Foolish Research coverage of the Rule Making networker. This is good stuff in case you've ever scratched your head over such troubling questions as... what the heck does Cisco actually do anyway?!
Bill Mann
TMFOtter on the Fool boards
